China in Transition

Advancement in Mixed-ownership Reform of State-owned Enterprises:
Focusing on the case of China Unicom

Chi Hung KWAN
Consulting Fellow, RIETI

The Chinese government has been committed to mixed-ownership reform, with a view to developing a competitive market environment and improving the governance of state-owned enterprises (SOEs). Mixed ownership has a macroeconomic aspect of a "mixed economy" comprising both SOEs and non-SOEs (private and foreign-owned enterprises), and a microeconomic aspect of "mixed-ownership enterprises" comprising both state-owned capital and non-state-owned capital (e.g., investment by private and foreign-owned companies, employees, etc.) A mixed-ownership enterprise generally adopts a shareholding system so as to make clear the rights of investors.

The mixed-ownership reform underway by the Xi Jinping administration places priority on promoting mixed-ownership enterprises over the mixed economy. A pilot program has already been launched to introduce private capital into selected SOEs. In particular, China Unicom's efforts to reform its primary business by bringing in new strategic investors, including many famous private companies, are drawing attention domestically and abroad as a model case of mixed-ownership reform of large-sized SOEs.

What is mixed-ownership reform?

In China, since the late 1990s, mixed-ownership reform has been a major component of SOE reform (Table 1). In particular, in the "Decision of the Central Committee of the Communist Party of China on Several Major Issues Concerning the Comprehensive Deepening of Reform" adopted at the Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC) held in November 2013, which presented the economic policy platform of the Xi Jinping administration, mixed ownership was characterized as "the prime method for materializing the basic economic system" of China. At the same time, "mixed-ownership reform" was assigned as a priority in SOE reform together with "the development of a modern corporate system" and "the improvement of the supervision and administration of state-owned assets."

Table 1. Reference to Mixed-ownership Reform in CPC's Important Documents
Month/year Document name Contents
September 1999
Fourth Plenary Session of the 15th Central Committee of CPC
CPC Central Committee's Decision on Several Major Issues Concerning Reform and Development of State-owned Enterprises State-owned capital can attract and organize more social capital through the shareholding system. It can also reinforce the function of state-owned capital, and strengthen the control power, influence and driving force of the state-owned economy. Large- and middle-sized state-owned enterprises, especially those in a dominant position, are suited to the shareholding system. These enterprises should be transformed into stock companies by means of rule-compliant listing on the market, merger with foreign-owned companies and cross-investment for the further development of the mixed-ownership economy. Controlling share of important enterprises should be retained by the state (government).
October 2003
Third Plenary Session of the 16th Central Committee of CPC
CPC Central Committee's Decision on Several Issues Concerning the Development of the Socialist Market Economy Further boost the mixed-ownership economy involving joint investment of state-owned capital, collective capital and non-public-owned capital so as to diversify investing entities. The shareholding system should be made as the major form of public ownership.
November 2013
Third Plenary Session of the 18th Central Committee of CPC
CPC Central Committee's Decision on Several Major Issues Concerning the Comprehensive Deepening of Reform Actively develop a diversified ownership economy. Diversified ownership integrated by state-owned capital, collective capital and private capital is the prime method for materializing the basic economic system, helping improve functions, increase value and promote the competitiveness of state-owned capital. Allow more state-owned enterprises and enterprises of other ownership types to develop into mixed-ownership enterprises. Non-state-owned capital should be allowed to invest in projects led by state-owned capital.
Note: The term "mixed-ownership economy" in the above table should be understood in a microeconomics sense (i.e., mixed-ownership enterprises), rather than a macroeconomic sense (i.e., mixed economy).
Source: Compiled by the author based on information published by Xinhua News Agency

In the "Guideline to Deepen Reforms of State-owned Enterprises" announced on September 13, 2015, based on the above decision, a policy was established to encourage participation of non-state-owned capital in SOE reform and investment in non-SOEs by state-owned capital and to seek adoption of employee stock ownership plans by mixed-ownership enterprises. In addition, SOEs are categorized into "for-profit enterprises" and "public welfare enterprises." The "for-profit enterprises" are further categorized into "competitive enterprises" (for-profit Class I) and "specific-purpose enterprises" (for-profit Class II). These categories have different reform policies.

More specifically, "for-profit Class I enterprises" primarily engaged in sectors with sufficient market competition, such as consumer goods, should diversify their share ownership structure by introducing other state-owned capital and non-state-owned capital through such means as listing of the entire group (including the primary business). This category of enterprises may not necessarily be controlled by state-owned capital.

Meanwhile, in the case of "for-profit Class II enterprises" primarily engaged in business which is important for the nation's security and economy, such as telecommunications, transportation, hydraulic power generation, petroleum, natural gas, electricity grid, nuclear power generation, and the defense industry, investment by non-state-owned capital should be encouraged, but domination of shareholding by state-owned capital should be retained.

In the case of SOEs categorized as "public welfare enterprises" (e.g., utilities, public transportation, and public facilities), participation in business management by non-state-owned entities shall be encouraged by such means as service procurement, concession, and outsourcing. In principle, enterprises belonging to this category must be 100% owned by state-owned capital; however, diversification of investors (investment by non-state-owned capital) should also be allowed subject to certain conditions.

The process of mixed-ownership reform of SOEs can be broadly divided into the following three categories:
(1) Dilution of state-owned capital: Reduce the shareholding ratio of state-owned holding companies by means of receiving investments from non-state-owned strategic investors.
(2) Separation of ancillary business from the main business: Separate an ancillary business division from the main business as a new company, and then invite private capital to invest in the new company.
(3) Joint market development: Incorporate a joint venture partly funded by non-state-owned capital to enter a new market.
Generally, dilution of state-owned capital is expected to lead to larger-scale reform and turn out to be more effective than the other two types, as this involves reform of the primary business of SOEs.

The case of China Unicom as a model

When China pursues an economic reform, it often launches a pilot program covering only limited enterprises (or regions) to verify its effects before full-fledged implementation. This is also the case with the current mixed-ownership reform. Since 2016, 19 SOEs covering seven industry sectors, namely, electricity, petroleum, natural gas, railway, aircraft, telecommunications, and defense were selected in two rounds of pilot tests.

One of the companies participating in the pilot tests is China Unicom, the third-largest state-owned telecommunication operator after China Mobile and China Telecom (Note 1). China Unicom is one of the "central enterprises" under the supervision of the State-owned Assets Supervision and Administration Commission of the State Council (98 enterprises as of October 2017), and is listed on the Shanghai "A-Share" market. China Unicom's operating revenue has been declining since 2013, as it has lagged behind the top two enterprises in the development of fourth-generation (4G) mobile telecommunications systems. China Unicom is now seeking to regain its presence through mixed-ownership reform.

China Unicom's mixed-ownership reform focuses on dilution of state-owned capital, targeting the primary business, which is the first attempt among central enterprises. China Unicom's mixed-ownership reform plan, announced on August 20, 2017, sets the following basic policy: "Under the comprehensive plan, proactively solicit domestic investors, reduce the state-owned share ratio and transfer a portion of shares to other state-owned shareholders and non-state-owned shareholders, so as to advance full-fledged mixed-ownership reform. Create a market-oriented corporate system and corporate governance structure, focus on both the company's primary business and new business models, develop both the basic and innovative businesses, and enhance the efficiency and competitiveness throughout the company. Achieve the company's strategic goals and contribute to the diffusion of IT in the nation's economy and society, structural reform of the supplier side, and shifting to a new growth engine."

Specifically, in order to implement the mixed-ownership reform, China Unicom is set to procure funds in the aggregate amount of about 78 billion renminbi (RMB; about $12 billion) through the following three avenues.
(1) Third-party allocation of shares: issue new shares at 6.83 RMB per share, with the maximum number of shares at around 9.037 billion shares, and allocate them to specific strategic investors, so as to raise about 61.725 billion RMB at a maximum.
(2) Share transfer: based on an agreement, transfer about 1.9 billion shares worth about 12.975 billion RMB to the National Fund for Structural Adjustment of State-owned Enterprises from China Unicom Group, the holding company of China Unicom, for 6.83 RMB per share (Note 2).
(3) Creation of an employee stock ownership plan: grant an option to key employees to acquire newly-issued shares for 3.79 RMB per share, with the maximum number of shares at around 848 million shares (2.7% of the total number of shares after the mixed-ownership reform), so as to raise about 3.213 billion RMB at a maximum.
Procured funds are to be used for the optimization of 4G, development of 5G, and the development of innovative businesses.

As a result of the mixed-ownership reform, strategic investors together will acquire 35.19% of China Unicom's total shares. On the other hand, the shareholding ratio of the China Unicom Group will decrease from 62.7% to 36.67% (Table 2). The investment ratios of these strategic investors estimated based on the cap on the number of shares issued are as follows: China Life Insurance Company (10.22%), Tencent (5.18%), Baidu (3.30%), (2.36%), Alibaba (2.04%), Suning Commerce Group (1.88%), Kuang-Chi (1.88%), Huaihai Ark (1.88%), Aegon-Industrial Fund (0.33%), and the National Fund for Structural Adjustment of State-owned Enterprises (6.11%).

Table 2. Change in Shareholding of China Unicom Due to Mixed-ownership Reform
(Shareholding ratio, in %)
Category Shareholder Before reform After reform
Largest shareholder China Unicom Group 62.7 36.67
Strategic investors Financial group China Life Insurance Company - 10.22
Internet service operators Tencent - 5.18
Baidu - 3.30 - 2.36
Alibaba - 2.04
Companies serving vertical markets Suning Commerce Group - 1.88
Kuang-Chi - 1.88
Huaihai Ark - 1.88
Industrial funds National Fund for Structural Adjustment of SOEs - 6.11
Aegon-Industrial Fund - 0.33
Employee stock ownership plan - 2.70
Public shareholders 37.3 25.40
Total 100.0 100.00
Note 1: Some strategic investors invest through their subsidiaries instead of directly.
Note 2: Due to rounding, the shareholding ratios may not add up to 100.
Source: Compiled by the author based on China Unicom "Public Notice on Particular Information on Situation Relating to China Unicom's Mixed-ownership Reform" (August 20, 2017)

As China Unicom is a "for-profit Class II" category enterprise, it has to remain under the control of state-owned capital. In fact, China Unicom Group will continue to be the largest shareholder of China Unicom even after the mixed-ownership reform. When the shares held by China Unicom Group are combined with those held by the National Fund for Structural Adjustment of State-owned Enterprises and China Life Insurance Company, state-owned capital will still account for over 50% of China Unicom's shares. This will make non-state-owned shareholders including strategic investors merely minority shareholders with limited influence over important decision making.

Strategic investors that are becoming the shareholders of China Unicom through the mixed-ownership reform are all in business closely linked to and with strong synergy with its primary business. China Unicom will develop new business and strive to build innovation capability through cooperation with strategic investors in such areas as cloud services, big data, Internet of Things (IoT), artificial intelligence (AI), home internet service, digital contents, retail systems, and electronic payment, while also reinforcing existing business segments.

Challenges to overcome

As is also the case with China Unicom, in general, mixed-ownership reform is expected to generate the following effects.

The first effect is the improvement of the business performance of the relevant SOEs. Introduction of non-state-owned capital is useful for the enhancement of productivity and profitability of an enterprise due to improved corporate governance.

The second effect is the elimination of monopolies by SOEs and lifting of the barrier for market entry by non-state-owned capital and entities. It has been very difficult for non-state-owned capital and entities to enter into the seven priority sectors for the mixed-ownership reform. The mixed-ownership reform paved the way for market entry into these sectors.

The third effect is the possibility of SOEs to procure fund for investment through the use of non-state-owned capital. This is expected to curb SOEs' dependency on debt issuance.

However, in order to achieve these effects, the following issues need to be solved (Liu Xingguo "Tackle difficult challenges, improve consensus, and advance mixed-ownership reform" Shanghai Securities News, August 20, 2016)

The first issue is the delay in the reform of institutions and mechanisms. Mixed-ownership reform of listed enterprises is only ending up in diversifying shareholders, falling short of establishing effective corporate governance structure of mixed-ownership enterprises. For mixed-ownership enterprises whose control is retained by state-owned shareholders, non-state-owned shareholders are often put into a disadvantageous position where their interests are impaired.

The second issue is that sectors which are attractive for private entities are dominated by SOEs and are not open for market entry, whereas most of the sectors where market access is permitted are not profitable and unattractive for private entities.

The third issue is that the state-owned asset supervising and managing authorities are still reluctant to transfer state-owned shares to private entities, due to the perception that private capital still poses a threat to state-owned capital and gives rise to economic instability.

The fourth issue is that, in the process of mixed-ownership reform, state-owned assets are often disposed of inappropriately, due to insufficient development of effective supervising mechanisms and the lack of laws and prescribed procedures regulating transfer of state-owned shares to private entities.

The fifth issue is that, while the government is trying to improve corporate governance and business results of SOEs through mixed-ownership reform, in reality, most SOEs are taking this opportunity to pass their non-performing business segments to private entities.

Finally, there is no mechanism for private entities to exit from mixed-ownership enterprises. In addition, exiting private entities may be criticized for stripping state-owned assets.

The need to eliminate monopoly and to advance privatization

The most important goals of mixed-ownership reform are the development of a competitive market environment and the improvement of corporate governance of SOEs. However, it is doubtful whether mixed-ownership reform is the most effective way to achieve these goals.

If the goal is to eliminate monopoly of state-owned capital in certain industrial sectors through the introduction of non-state-owned capital, the most effective way would be to lower the barriers for market entry and to allow private enterprises to compete on an equal footing with SOEs. The market competition that results would motivate SOEs to improve their corporate governance, productivity, and competitiveness.

If the goal is to change the management structure of SOEs, including corporate governance, the state as represented by the government would need to abandon its dominant position in the shareholding structure by way of privatization (See Box). As long as the government remains the dominant stakeholder, business management of SOEs is unlikely to change drastically.

Thus the ongoing mixed-ownership reform should be a first step toward privatization, not the final stage of SOE reform.

Box: Why is it difficult for SOEs to establish effective corporate governance
(Opinion of Peking University Professor Zhang Weiying)

In China, some argue that the focus of SOE reform should be corporate governance rather than ownership structure, and that by improving their corporate governance, SOEs would be able to achieve efficiency on par with private enterprises. However, Peking University Professor Zhang Weiying argues that it is impossible for SOEs to establish effective corporate governance based on the following observations. (Zhang Weiying "Establishing effective corporate governance of SOEs would be impossible," Cai Zhi Dao, 198th Issue,, February 28, 2014)

Corporate governance has two fundamental functions: one is to select talented entrepreneurs as top executives, and the other is to motivate, supervise, and manage the top executives.

In private companies, it is the "shareholders" who primarily play these two roles. Due to such factors as asymmetry of information, it is not easy to pick the right top executives and supervise and manage them properly. Shareholders (in particular, large shareholders) strive to perform these roles in a proactive way, because incompetent top executives unconcerned with corporate value will cause loss to their property. Corporate governance can be achieved through such means as shareholders meetings, board meetings, audit committees, stock options for executives, employees' bonuses, stock market transactions, M&A, and the trust of stakeholders.

On the other hand, if one asks whether it is possible for SOEs to firmly establish effective corporate governance, the answer is "No," because SOEs are owned by the state, not individuals. Politicians and bureaucrats entrusted with the management of SOEs have disproportionate powers relative to responsibilities, which means that they can exercise the same rights like shareholders of private entities in appointing and supervising top executives of SOEs, but they do not have to bear the consequences. Whether or not these enterprises are making money has little effect on their salaries. Unlike shareholders of private entities, they have no incentive to appoint talented entrepreneurs to become executives and to supervise them in the performance of their duties. Executives of SOEs also lack entrepreneurial spirit, and they only seek career success as bureaucrats. They may try to improve corporate profit in the short term, but they have little interest in technology development and innovation which require a long time to achieve results.

Professor Zhang's conclusion that "it is impossible for SOEs to establish effective corporate governance" would also apply to mixed-ownership enterprises over which state-owned capital retains control.

The original text in Japanese was posted on October 20, 2017.

  1. ^ According to "Fortune Global 500" published in 2017 by Fortune magazine, China Mobile ranks 47th, China Telecom 133rd, and China Unicom 241st in terms of revenue.
  2. ^ The National Fund for Structural Adjustment of State-owned Enterprises was established through contributions from central and local SOEs and financial institutions including China Chengtong Holdings Group Ltd. (principal initiator), CCB Financial Asset Investment Co., Ltd., China Merchants Jinkui, China North Industries Group Corporation, China Petroleum and Chemical Corporation, Shenhua Group, China Mobile, China Communications Construction, CRRC Capital and Beijing Financial Street Investment Group Co., Ltd. As the main business, the Fund provides services for the development of central enterprises, industrial sector-wide integration and reorganization, adjustment of production capabilities and cross-border M&A.
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